Do you like the idea of family members living nearby, but still want the privacy of living in separate spaces? Or are you looking to earn extra income from unused parts of your home or property?

There is a solution you may not have considered.

Meet the accessory dwelling unit (ADU). An ADU is a small house or apartment on the same lot as a larger, single-family home.

ADUs are fully functional residences in their own right, with a kitchen, bathroom, living area, sleeping area, and separate entrance. You’re probably already familiar with the concept, if not the technical term. ADUs go by other names, such as granny flats, guesthouses, or in-law suites. You might recall the television show Happy Days, where Fonzie lives in an apartment above the Cunninghams’ garage — that’s an ADU, too.

Note that ADUs are not “tiny homes.” Tiny homes are built on a trailer with wheels and are technically classified as recreational vehicles. By contrast, ADUs are permanent structures built on a fixed foundation.

Typically, homeowners build ADUs for two reasons: to generate rental income or to create flexibility for a multigenerational household. A decent number of homeowners are looking into this option. In 2019, the National Association of Home Builders reported that one-fifth of remodeling contractors participated in projects to create an ADU, either by building an addition or converting an existing space.

In light of the pandemic, interest in multigenerational housing has grown even more.

A recent National Association of Realtors report found that 15% of home buyers purchased multigenerational homes after the pandemic began, versus 11% before.

“The biggest factor that seems to be pushing this is taking care of or spending more time with aging parents or adult relatives,” says Jessica Lautz, Ph.D., vice president of demographics and behavioral insights at the National Association of Realtor.

If the idea of an ADU is intriguing to you, the first thing to do is find out if your municipality allows them. Local regulations are typically the biggest barrier to building an ADU.

And even if ADUs are allowed, there may be rules you must follow around owner occupancy, parking requirements, square footage, and the look of the structure. You can find out these details by contacting your local zoning office or planning office.

Whom ADUs Make Sense For

Building an ADU can be useful for a variety of individuals and scenarios.

Consider the following types of people who might live in an ADU:

• Parents who want to live closer to kids and grandkids, full-time or part of the year
• Aging or disabled relatives who need some care, but can live independently
• Adult children or grandchildren, while they attend college or get started in life
• Visiting guests
• Caregivers for the homeowner
• A long-term tenant, providing ongoing income
• Guests through short-term rental services, such as Airbnb
• The homeowners themselves, who downsize while renting the larger house to a family member or tenant

Perhaps the main advantage of ADUs is their flexibility.

Once the space is built, it can move between any of these scenarios as needed over time.

How Much an ADU Costs

Cost varies greatly, depending on the type of ADU you build. The least expensive options are converting existing structures.

Examples of this approach would include creating an ADU by converting a garage or renovating a basement or attic. You could feasibly build an ADU this way for $40,000 to $60,000, provided the underlying structure is in good shape. For a detached unit built from scratch, expect to spend $100,000 or more for a small footprint of 400 square feet. For a larger ADU of 800 square feet, experts in this area estimate the baseline cost at $180,000.

People certainly spend more than that. “Definitely there’s some getting built for $300,000-plus.

These estimates are for total project costs, including permitting, design, and construction, and they are based in the Portland, Oregon, a place where ADU’s are popular. A local contractor can give you quotes specific to your area and property.

How to Pay for an ADU

Building an ADU is an expensive endeavor, and most homeowners cover the cost with a mix of sources.
Most people use a combination of:

• Accessing home equity, via a home equity line of credit or a cash-out refinance. This is the most common way homeowners cover the bulk of costs.
• Cash savings or liquidated stocks.
• 401(k) loans.
• Loans from family and friends.
• Sweat equity, where homeowners do the work they can themselves.

Other, less-common options include:

• Grants from nonprofits, intended to increase affordable housing stock in a given area.
• Renovation loans from banks, which consider the future value of the property once the ADU is built.
• Developers that cover the cost of construction, in exchange for a portion of the rental income.

How to Calculate if Building an ADU Is Worth It

While many people build their an ADU for non-financial reasons, considering the money ramifications is only prudent. Here are some questions to ask yourself:

Can an ADU save my family money elsewhere?

Building an ADU for a loved one may mean you can save on assisted living care, which costs an average of $4,000 a month. You also may not need to spend time and money traveling to check in on relatives or supervise their caregivers.

Can an ADU provide rental income?

If there is demand for rental properties in your area, you may be able to lease the ADU to long-term tenants. If your location is near a major city or tourist attraction, making the ADU a short-term rental through Airbnb may be profitable as well.

Can an ADU increase my property value?

It’s difficult to say for sure, given how varied housing markets are nationwide and how limited the data is on ADUs right now. However, in the above example in Portland, an ADU increases property value by 50% of what it costs to build.

Lautz, from the National Association of Realtors, suggests that any addition of square footage, if well-designed, will increase a home’s appeal to future buyers.

One final question to ask is how prepared you are to manage a very large project like building an ADU. Given the time and effort involved, it could be the second biggest endeavor of your life, such as having a child or buying and moving into your dream home.

You have to be extremely motivated, have the right financial formula going for you, and be in a city that has good regulation. So if all those factors are just right, then an ADU can make sense.